■ MODEL ANSWERS
TO PREVIOUS SHORT QUESTIONS OF FINANCIAL MGMT 1
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FINANCIAL
MGMT
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SHORT
QUESTIONS
■
DISTINGUISH BETWEEN GROSS WORKING CAPITAL AND
NET WORKING CAPITAL
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WHAT IS SCRIP DIVIDEND?
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WHAT IS WEIGHTED AVERAGE COST OF CAPITAL
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WHAT DO YOU MEAN BY ARR?
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WHAT IS STABLE DIVIDEND POLICY?
■
WHAT ARE SWEAT EQUITY SHARES?
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DISTINUGISH
BETWEEN EXPLICIT AND IMPLICIT COST OF CAPITAL
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WHAT IS MEAN Y STOCK SPLIT?
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WHAT IS CAPITAL GEARING?
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WHAT IS OPERATING LEVERAGE?
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DISTINGUISH BETWEEN GROSS WORKING CAPITAL AND
NET WORKING CPAITAL
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MEANING OF WORKING CAPITAL:-WORKING CAPITAL
REFERS TO THAT PART OF THE FIRM’S CAPITAL WHICH IS REQUIRED FOR FINANCING SHORT
TERM OR CURRENT ASSETS SUCH AS CASH.MARKETABLE SECURITIES,DEBTORS AND
INVENTORIES ETC
■
GROSS WORKING CAPITAL IS THE CAPITAL INVESTED
IN TOTAL CURRENT ASSETS OF THE ENTERPRISE. CURRENT ASSETS ARE THOSE ASSETS
WHICH IN WHICH THE ORDINARY COURSE OF THE BUSINESS CAN BE CONVERTED INTO CASH
WITH IN SHORT PERIOD.
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CURRENT ASSETS:-CASH IN HAND,CASH AT
BANK,SUNDRY DEBTORS,SHORT TERM LOANS ,ACCRUED INCOME.PREPAID
EXPENSES,STOCK,SHORT TERM INVESTMENTS
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NET WORKING
CAPITAL
NET WORKING
CAPITAL MEANS CURRENT ASSETS MINUS CURRENT LIABILITIES.
NET WORKING
CAPITAL = CA-CL
IT MAY BE
POSITIVE OR IT MAY BE NEGATIVE
CURRENT
LIABILITIES ARE THOSE LIABILITIES WHICH ARE TO BE PAID WITH IN LESS THAN ONE
YEAR.
CURRENT
LIABILITIES:-BILL PAYABLE,SUNDRY CREDITORS,OUTSTANDING EXPENSES,BILL
PAYABLE,SHORT TERM LOANS AND ADVANCES,DIVIDEND PAYABLE,BANK OVERDRAFT ETC
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■
DIFFERENCE
BETWEEN GROSS WORKIGN CAPITAL AND NET WORKING CPAITAL
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GROSS WORKING CAPITAL IS
a. BROADER
CONCEPT
b. GOING CONCERN
CONCEPT
c. MORE USEFUL
IN DETERMINING THE RATE OF RETURN
d. IN ESTIMATING
THE CORRECT AMOUNT OF FUNDS
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NET WORKING CAPITAL IS
I.
NARROW CONCEPT
II.
QUALITATIVE CONCEPT WHICH HIGHLIGHT LIQUIDITY
POSITION
III.
MARGIN OF PROTECTION AVAILABLE TO CREDITORS
IV.
INDICATOR OF FINANCIAL SOUNDNESS
■
WHAT IS
SCRIP DIVIDEND
■
ALSO KNOWN AS BOND DIVIDEND, A SCRIP DIVIDEND
PROMISE TO PAY SHAREHOLDERS AT A FUTURE SPECIFIC DATE. WHEN THE COMPANY DOES
NOT HAVE SUUFICIENT FUNDS TO PAY DIVIDEND IN CASH, IT MAY ISSUE NOTES OR BONDS
FOR THE AMOUNT DUE TO SHARHOLDER ON ACCOUNT OF DIVIDEND.
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HERE THE PURPOSE IS TO POSTPONE THE IMMEDIATE
PAYMENT OF CASH. A SCRIP DIVIDEND BEARS
INTEREST AND IS ACCEPTED AS COLLATERAL SECURITY.
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WHAT IS
WEIGHTED AVERAGE COST OF CAPITAL?
■
ALSO KNOWN AS A COMPOSITE COST OF
CAPITAL,OVERALL COST OF CAPITAL/AVERAGE COST OF CAPITAL
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WEIGHTED AVERAGE COST OF CAPITAL IS THE AVERAGE
COST OF THE COSTS OF VARIOUS SOURCES OF FINANCING.
■
FIRST WE HAVE TO CALCULATE THE SPECIFIC COST OF
INDIVIDUAL SOURCES OF FINANCE AND THEN WE CALCULATE WEIGHTED AVERAGE COST OF
CAPITAL BY PUTTING WEIGHTS TO THE SPECIFIC COSTS OF INPROPORTION OF THE VARIOUS
SOURCES OF THE FUNDS TO TOTAL
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WEIGHTS MAY BE BOOK VALUE OR MARKET VALUE
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KW= ∑XW/∑W
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KW= WEIGHTED AVERAGE COST OF CAPITAL
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X= COST OF SPECIFIC SOURCE OF FINANCE
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W=WEIGHT PROPORTION OF SPECIFIC SOURCE OF FINANCE
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KW=
WEIGHTED AVERAGE COST OF CAPITAL
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X= COST OF SPECIFIC SOURCE OF FINANCE
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W=WEIGHT PROPORTION OF SPECIFIC SOURCE OF FINANCE
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MEANING OF
EXPLICIT COST OF CAPITAL AND IMPLICIT COST OF CAPITAL
■
EXPLICIT COST IS THE DISCOUNT RATE WHICH
EQUATES THE PRESENT VALUE OF CASH INFLOWS WITH THE PRESENT VALUE OF CASH
OUTFLOWS. IN OTHER WORDS,IT IS THE INTERNAL RATE OF RETURN.
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THE EXPLICIT COST OF SPECIFIC SOURCES OF
FINANCE:-
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I0= (O1/ (1+K)) + (O2/
(1+K) 2 -------+ (ON/ (1+K)N
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I0= NET CASH FLOW AT ZERO POINT
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O= IS THE OUTFLOW OF CASH IN DIFFERENT TIME
PERIOD
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K= IS THE EXPLICIT COST OF CAPITAL
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IMPLICIT COST OF CAPITAL
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AS THE OPPORTUNITY COST IS THE COST OF
OPPORTUNITY FORGONE IN ORDER TO TAKE UP PARTICULAR PROJECT. FOR EXAMPLE THE
IMPLICIT COST OF RETAINED EARNING IS THE RATE OF RETURN AVAILABLE TO
SHAREHOLDERS BY INVESTING THE FUNDS ELSEWHERE.
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ACCOUNTING
RATE OF RETURN
■
TAKES INTO ACCOUNT THE EARNING EXPECTED FROM
THE INVESTMENT OVER THEIR WHOLE LIFE. HERE THE ACCOUNTING CONCEPT OF PROFIT (NET
PROFIT AFTER TAX AND DEPRECIATION) IS USED RATHER THAN CASH FLOW AFTER TAX BUT
BEFORE DEPRECIATION.
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VARIOUS PROJECTED ARE RANKED ON THE BASIS OF
RATE OF RETURN AND THE PROJECT IS SELECTED WHICH GIVES HIGHEST ACCOUNTING RATE
OF RETURN AND THE ONE WHICH GIVES LOWER RATE OF RETURN IS REJECTED.
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FORMULAS
I.
AVERAGE RATE OF RETURN= (AVERAGE PROFIT AFTER
DEP AND TAXES/NET INVESTMENT IN THE PROJECT)X100
II.
RETURN PER UNIT OF INVESTMENT METHODS= TOTAL
PROFIT AFTER DEP AND TAXES/NET INVESTMENT IN THE PROJECT)X100
III.
RETURN
ON AVERAGE INVESTMENT METHOD= (TOTAL PROFIT AFTER DEP AND TAXES/AVERAGE
INVESTMENT IN THE PROJECT)X100
IV.
AVERAGE RATE OF RETURN ON AVERAGE INVESTMENT=
(AVERAGE PROFIT AFTER DEP AND TAXES/AVERAGE INVESTMENT IN THE PROJECT)X100
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EVALUATION
■
MERIT
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SIMPLE TO UNDERSTAND
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USES THE ENTIRE EARNIGNG
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BASED UPON ACCOUNTIGN CONCEPT OF PROFIT AND CAN
BE EASILY CALCULATED
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DEMERIT
I.
IT ALSO IGNORES THE TIME VALUE OF MONEY
II.
DOES NOT TAKE INTO CONSIDERATION THE CASH FLOWS
WHICH ARE MORE IMPORTANT THAN THE ACCOUNTING PROFIT
III.
IGNORES THE RISK
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STABLE
DIVIDEND POLICY
■
IT MEANS PAYMENT OF DIVIDEND REGULARLY AND
STABILITY OF DIVIDEND MEANS UNIFORMITY OR NO VARIBAILITY IN THE STREAM OF
DIVIDEND PAYMENTS.
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IT MEANS PAYMENT OF CERTAIN PAYMENT OF DIVIDEND
REGULARLY.
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STABILTY OF DIVIDEND CAN BE DONE IN THE
FOLLOWING WAYS:-
•
CONSTANT DIVIDEND PER SHARE:-FIXED DIVIDEND PER
SHARE IRRESPECTIVE OF PROFIT
•
CONSTANT PAY OUT RATIO:-FIXED PERCENTAGE OF NET
EARNING
•
STABLE RUPEE DIVIDEND PLUS EXTRA DIVIDEND:-
PAYING FIXED LOW DIVIDEND PER SHARE PLUS AN EXTRA DIVIDEND IN THE YEARS OF
HIGHER PROFIT
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WHAT IS SWEAT
EQUITY SHARES?
■
SWEAT EQUITY SHARES MEANS SUCH EQUITY SHARES AS
ARE ISSUED BY A COMPANY TO ITS DIRECTORS OR EMPLOYEES AT A DISCOUNT OR FOR
CONSIDERATION OTHER THAN CASH,FOR PROVIDING THEIR KNOW HOW OR MAKING AVAILABLE
RIGHTS IN THE NATURE OF INTELLECTUAL PROPERTY OF VALUE ADDITIONS BY WHAT EVER
NAME CALLED
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CONDITIONS FOR ISUUE OF SWEAT EQUITY SHARES:-
I.
PASSING OF SPECIAL RESOLUTIONS AND ALSO SPECIFY
THE NUMBER OF SHARES,CURRENT MARKET PRICE AND THE CLASS OF DIRECTORS/CLASSES OF
EMPLOYEE
II.
IT IS VALID FOR MAKING THE ALLOTMENT WITH IN A
PERIOD WHICH IS NOT MORE THAN 12 MONTHS FROM THE DATE OF PASSING OF SPECIAL
RESOLUTION
III.
LOCK IN PERIOD IS THREE YEARS
IV.
THE COMPANY SHOULD BE AT LEAST INCORPORATED FOR
ONE YEARS
V.
IF THE COMPANY’S SHARES ARE LISTED THEN FOLLOW
THE CONDITIONS OF SEBI
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STOCK SPLIT
■
STOCK SPLIT IS A CORPORATE ACTION IN WHICH A
COMPANY DIVIDES ITS EXISTING SHARES INTO MULTIPLES SHARES TO BOOST THE
LIQUIDITY OF THE SHARES. AS THE NUMBER OF SHARES INCREASES PRICE PER SHARE GOES
DOWN. MARKET CAP REMAINS THE SAME
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FOR EXAMPLE IN 2 FOR ONE STOCK SPLIT AN
ADDITIONAL SHARE IS GIVEN FOR EACH SHARE HELD BY SHAREHOLDER.
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CAPITAL
GEARING
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THE TERM CAPITAL GEARING REFERS TO THE
RELATIONSHIP BETWEEN EQUITY CAPITAL AND LONG TERM DEBTS.
■
CAPITAL GEARING MEANS THE RATIO BETWEEN THE
VARIOUS TYPES OF SECURITIES IN THE CAPITAL STRUCTURE OF THE COMPANY.
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A COMPANY IS SAID TO BE IN HIGH GEAR WHEN IT
HAS A PROPORTIONATELY HIGHER ISSUE OF DEBENTURE AND PREFERENCE SHARES WHERE AS
LOW GEAR MEANS LOW SHARE OF DEBT AND PREFERENCE AND MORE SAHRE OF EQUITY.
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OPERATING
LEVERAGE
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OPERATING LEVERAGE IS THE DEGREE TO WHICH A
FIRM OR PROJECT CAN INCREASE OPERATING INCOME BY INCREASING REVENUE. IT RESULT
FROM THE PRESENCE OF FIXED COST THAT HELP IN ENHANCING NET OPERATING INCOME
FLUCTUATIONS FLOWING FROM SMALL
VARIATIONS IN REVENUE. ANY INCREASE IN SALES, FIXED COST REMAINING THE SAME,
WILL MAGNIFY THE OPERATING REVENUE. THE DEGREE OF OPERATING LEVERAGE DEPENDS
UPON THE AMOUNT OF FIXED ELEMENTS IN THE COST STRUCTURE. IT CAN BE DETERMINED
BY MEANS OF BREAK EVEN OR COST VOLUME PROFIT ANALYSIS.
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OPERATING LEVERAGE= CONTRIBUTION/OPERATING
PROFIT
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DEGREE OF OPERATING LEVERAGE=PERCENTAGE CHANGE
IN PROFITS/PERCENTAGE CHANGE IN SALES
Very informative
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